Saturday, June 16, 2012

Debt, Depression, and Political Extremism: A Useful Reminder

I have been arguing (“Euro Exit”, 2012) that the best way out of the deflationary policy of “austerity” imposed to Eurozone countries by the German government is a substantial devaluation of the euro against the dollar and the yuan, around or under a one-for-one pricing, whereas the exchange rate is still fluctuating today around 1.26 dollars to the euro. Such a depreciation would return many of the “GIPSIs” (Greece, Ireland, Portugal, Spain, Italy) to competitiveness (more exports and less imports from out of the zone countries) and moreover would open a window of opportunity for a low cost exit from the euro and a return no national currencies, since the burden of debts in euros would be reduced accordingly at the same time. Exiting the euro would prove necessary anyway in order to realign intra Eurozone exchange rates to an approximate equilibrium value that would take into account the cumulative divergence of unit costs and prices between the southern members and Germany during the 1999-2012 period.

An argument often used however in favor of the euro, and a euro as strong as the DM, by bankers and eurocrats is that the German opinion is acutely remembering that a reduction of external debt by devaluation has been leading to hyperinflation in the 1920s, and as a consequence to the destruction of the middle class, and then Nazism.  

They are wrong on two counts: first, the present international environment is resolutely non inflationary, in spite of the huge amount of money created in the world by US “quantitative easing” policy. The globalization phenomenon has brought in a massively increased supply of goods and services from the emerging economies so that more money is chasing more goods, and the perspective of inflation is still remote for the moment. A devaluation therefore is not likely to boost inflation much. And second, their claim is historically wrong: the rise of the Nazis was not in the 1920s crisis but followed the 1930s Great Depression that hit Germany most. The share of the Nazis in the votes stayed at a low level throughout the 1920s (a few percent) and then rised massively in the 1932 elections to more than a third of the total vote, at the moment when the effects of Depression were being felt.

This point is usefully developed in The Economist "Charlemagne" blog this week (“Between two nightmares”). In her belief that budget profligacy leads to political chaos and political extremism, Mrs. Merkel, they write, is drawing the wrong lesson from history:

“It was not hyperinflation in the 1920s but the depression and mass unemployment in the 1930s that propelled Hitler to power. Like the hapless Weimar chancellor, Henrich Brüning, Mrs. Merkel is accused by the critics of hastening disaster by pushing austerity during a deep recession. But whereas the 1930s is seared in American memory, it is less clearly remembered in Germany. The reason, says Professor Carl-Ludwig Holtfrerich of the Free University of Berlin, is that Germany returned to full employment more quickly, thanks partly to Hitler’s own form of Keynesian stimulus: notable autobahn-building and rearmament.

The prospect of a 1930s-like breakdown now is perhaps most palpable in Greece.”

I completely agree that Greece is a clear example of deflationary policy leading, in the context of an incoming depression, to political extremism.
But I believe that the reason for German obstinacy regarding austerity and deflation has much more to do with current factors rather than with historical memories.

First, the German opinion opposes a “transfer union” and is quite right to do so since there is no end in view for depression and induced growing budget unbalances in the GIPSIs, as long as they cannot recover their monetary independence, and thus economic growth. Second, the German re-export model implies that the concerned industries prefer to keep in place the euro that gives them an unfair exchange rate advantage over southern Eurozone countries, and they would significantly lose profits in case these countries exit the Eurozone. Third, the banks and the German government gain much from the overvalued, “DM-like” euro, in that the flow of international capital to Germany, and the zero interest rate that is its result, provide these structural borrowers with ample funding at zero cost. One has to be reminded that the German government is as heavily indebted as France is for instance.

Thus, let’s not forget the lessons of the 1930s, rather than those of the 1920s, on the one hand, but let’s not forget the present rational factors of the growing conflict between the current Eurozone members’ interest groups.

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